Last week we ran the first part of our attempt to explain some aspects of the new real estate taxes that the government has imposed because the construction sector has been doing so well. We talked about the new fixed taxes on builders and developers, the changes the principle of Fair Market Value and valuing immovable property. In the second part of this guide, we bring you scenarios to understand the new rules on capital gain, advance taxes and those on rental income.
Capital gain on immoveable property
Capital gains is the amount of money that emerges (an increase) over the initial amount that was invested in real estate at the time it was bought. You get this figure by subtracting the original purchase price and selling price. And if you have capital investments that could make you a profit if you sold them, it means you have unrealized (untapped) “capital gains”. Realized capital gains are what you get from selling investments.
This tax is applicable to ‘immoveable property’, which literally means any asset or property that cannot be moved. This includes plots, land, buildings, houses (real estate) whether for personal use or business. Capital gains tax has to be paid at the time you make a profit when selling or disposing of this property. You only have to pay tax on capital gain if you sell your investment. If we were to write it in an equation it would look like this formula: Capital gain = selling price of asset – original price of asset.
So, if the original price of a house you’re selling is Rs10 million and you sell it for Rs20 million your profit is Rs10m—your capital gain. You now pay tax on this Rs10m profit. And the capital gains tax is paid according to the holding period. (A holding period is the length of time that the property is held or owned.)
So for property acquired on or after July 1, 2016 and a holding period of up to one year it is 10%, more than one year but less than two years it is 7.5%, more than two years but less than three years it is 5% and none is payable if it is held for over three years. For property acquired before July 1, 2016 it is 5% tax payable on the profit for a holding period of up to three years and none for over three. Let’s look at a couple of situations, keeping in mind the above rules:
In scenario 1, let’s imagine you acquired the house mentioned above in January 2013 and are considering selling it in August 2016. You don’t have to pay any tax on any profit you make because the holding period is over three years and this makes it a personal asset and not a business commodity. In scenario 2, if the house is bought in August 2016 and sold in August 2017, you have to pay a 10% tax on the Rs10m profit you make.
This tax is only paid when you make a profit on selling property. It is paid by anyone (a person or business) selling their property for profit within three years of acquiring it. People have been paying it in the past and it is reported in their income tax returns.
It was in the Finance Act of 2012 that capital gains tax was included for the first time on transactions for immovable properties. After 2012 and before the Finance Act of 2016, capital gains on immovable properties sold after holding them for one year and up to two years was charged a tax at the rates of 10% and 5%, respectively and capital gains on property sold after more than two years were exempted.
Time limits have been set to cater to cases of gains arising from frequent buying and selling of property, described in the law as ‘an adventure in the nature of trade.’ If you’re selling and buying property as a part of your business, then the property becomes your stock or good, in which case you’re supposed to pay taxes. No taxes are to be imposed on you if, for instance, you sell an ancestral house, which you had for several years (or any property held for more than five years).
People should know that the tax on the sale or transfer of immoveable property has been increased from 0.5% to 1% for people who file tax returns and from 1% to 2% for people who fail to do this. And when it comes to the purchase of immoveable property it has been increased from 1% to 2% for filers and from 2% to 4% for non-filers. These are collected as advance taxes and are adjustable. Adjustable means taxes which are refundable.
A few examples might help explain: Let’s assume Hanif does not file his tax returns. He bought a plot in March 2015 for Rs8m and now he wants to sell it in August 2016. The FBR has set the rate at Rs16m. He has to pay 2% in advance income tax or Rs320,000 as he is a non-filer. Once he files his income tax returns, he can get a refund. The capital gain on the sale of the property is Rs16m minus Rs8m or Rs8m. The tax rate for property held less than five years is 5%.
Now let’s assume Hanif files his income tax returns. He wants to sell the same plot. His advance income tax rate is now lower, 1%. So he has to pay Rs160,000 (as opposed to Rs320,000 as mentioned above). Once again, it is refundable. The capital gain on the sale of property is still Rs8m and because he held the plot for less than five years, he has to pay 5% tax.
If you are selling your plot in Gulshan, Karachi, you need to pay advance tax based on the FMV determined by the FBR, to the authority that is responsible for registering or transferring immoveable property. However, the tax shall only be paid if the holding period of the plot does not exceed five years. If it is over that period, no tax is payable. This tax shall be paid to the authority at the rate of 1% if you are an income tax return filer and 2% if you are not. The tax is refundable.
Tax on rental income
The rules have been also simplified when it comes to property income, which has now been separated. Earlier on, income from property (rent) was clubbed with income falling under other categories like income generated through salary and business. Now, the tax is to be imposed on the gross amount as opposed to the net amount. Gross amount means the total revenue generated through rental income without any deductions/allowances/expenditure costs etc. Consider this example:
Previously, if you earned Rs500,000 per year in income by renting an apartment, you were supposed to pay tax on the net amount after combining this amount with income under other heads. So, let’s assume that under rental property your expenditure for the whole year amounted to Rs100,000, the net amount was taken down to Rs400,000. This amount was then added to your income under other heads, which let’s assume is salary. If your salary was Rs500,000, your total income was calculated to then be Rs900,000.
However, now, the situation has changed quite a bit. So, Rs500,000, which is the gross amount you get from renting out an apartment, is now taxable separately. The rates are specified in the Income Tax Ordinance, 2001.
The author is posted as the Deputy Commissioner (Inland Revenue), Large Taxpayers’ Unit, Islamabad, and is also a blogger at www.theislamabaddiaries.com. She can be reached at [email protected]